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The big picture in fixed income

Investors have never had more to consider as they set their fixed-income allocations. The global interplay of macroeconomic signals, policy decisions and financial conditions is increasingly intricate. Technological change is tempering inflation, differentiating issuers and informing investment strategies. With so much to monitor, maintaining a comprehensive view that spans sectors, strategies and regions is challenging - and essential.

As monetary policy normalizes, the implications for all fixed income investors are significant—but not necessarily the same. We asked four BlackRock CIOs to review current trends in fixed income from their varying vantage points.

Market landscape

Fiscal stimulus in the U.S. has produced a burst of growth and provided a backdrop for Fed rate hikes. At the same time, a strong U.S. dollar is intensifying the global effects of reduced liquidity, especially in emerging markets. CIO of Global Fixed Income Rick Rieder reviews these developments and their implications for portfolio construction.

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Rick Rieder

What are your thoughts on the global economic landscape?

Whether it's technology, or the fact that you're seeing some softness in places like housing, we think this is an economy that's changing, that is actually . . . You're seeing global growth that's moderating. So for fixed income, it's a really big deal.

But the movement, significant movement higher in interest rates, we think has happened. And I think that's a really big deal because we're in an economy that's changing. A lot of the stimulus has all come in, monetary fiscal has all come in, and you're seeing that burst of growth.

. . . And the Fed has got to react to that. But I think over the next couple of quarters, you'll see it where the Fed doesn't have to necessarily move as quickly. And it creates a much more stable dynamic, we think, in terms of the fixed-income market.

How are you suggesting clients position their fixed income portfolios?

When you talk about what's the story of the year in fixed income and we talk about trade . . . We can talk about tariffs. We can talk about growth in the economy. The one big thing that's different for fixed income, the major thing, is that now the front end of the yield curve has moved up. We've talked for years about the Fed needs to lift interest rates, rates need to rise. It happened.

So now you can feel like you can build a portfolio where you can use the risk-free rate for the first time and actually get fair value in the risk-free rate. You can use front-end Treasuriess and marry them to assets that are riskier:. And now you feel like you're creating – particularly as you're getting to the end of the business cycle and you can define how long that will extend for. But now you're creating a dynamic that it's a much more stable portfolio.

For the first time, I would say, in a number of years in fixed income, I feel like: "My gosh. Now I can use much more of the tool kit to buy stuff that has value." And you don't have to stretch as far as you did before.

How is technology impacting your approach to risk management?

I think the way we manage fixed income is changing so darned quickly, not dissimilar from other industries today. We're using a series of tools across all of our platform[s], where we look at – you know, we do a lot with regime identification, understand what the big macro picture is. And then we use a lot of things like systematic signals and tools to look at Big Data, to look at data assimilation into our portfolios. The other big thing in terms of – that I think is a game changer in terms of active management is the ability to create an efficient portfolio.

And that, I think, is a really big deal. We're using a tremendous amount of technology today to build what we think is a stable portfolio where you have diversification, where you're managing your correlations effectively. You're thinking about where you own the risk-free rate in the world, where you own – you know, how much credit risk are you taking, how much bank-capital risk are you taking, and to build an efficient portfolio. Technology today is allowing us to run hundreds of thousands of simulations in a portfolio nightly, literally nightly, to look at stress-testing-scenario analysis.

We think efficient portfolio construction today is where we're using a lot of the technology today to create what we think is a much more stable portfolio that has a higher Sharpe ratio over time.

Investing toolkit

CIO of systematic fixed income Tom Parker discusses the respective roles of two kinds of active management: systematic, with its focus on breadth, and fundamental, with its focus on depth.

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Tom Parker

How do you suggest clients consider combining the various approaches to fixed income investing?

It's a key decision point, if you're constructing a portfolio, of how are you going to mix all these various properties of active, fundamental, systematic, passive.

And the real key – let's take fundamental versus systematic to start with – is . . . The key to systematic is breadth, is that you can make lots of decisions, you can look at lots of companies. You don't have the limits of human attention in a systematic process, and so you want to be a breadth player. And so you want to make portfolio decisions that involve: Where does breadth give me a competitive advantage?

If you think about fundamental, it's depth. An analyst can look at a situation and get really down and dirty, talk to lawyers, talk to environmentalists, do all kinds of things. But you can't repeat that over a large number of credits or companies or countries because it takes that attention and that attention to detail. So combination of systematic and fundamental is kind of a core and satellite. You want your core to not only give you really controlled factor exposures, which systematic can do. It can give you that alpha that comes from the breadth that you're looking at, and you can make relative-value calls across lots of different assets.

The new study by Greenwich Associates points to the steady growth of U.S. and European institutions considering bond ETFs as an alternative vehicle for fixed-income exposures, as a result of investors’ continued concerns about bond liquidity.

Late cycle concerns

An aging economic expansion, high asset prices and bouts of volatility are raising concerns, yet companies have strong earnings and good interest coverage on their debt. James Keenan, CIO of Global Credit, shares his thinking on how to read the cycle.

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James Keenan

What factors do you think are most influential on the fixed income markets today?

Policy is becoming a little bit more localized relative to where different regions and different countries are in the cycle, and you've moved away from the deflationary fears. And that change in policy is creating a broader range of uncertainty around economic outcomes. But it's increasing the structural volatility. It's increasing dispersion. And that's certainly got everyone thinking about their allocations.

What are the leading concerns you are hearing from clients about credit markets?

Where we are in the economic cycle is the biggest question you're going to have. Obviously, the policy is shifting because the economic environment has changed. The valuations are very high, and clients are worried about the downside risk and their protection at the same time that asset prices are high and it's not providing for a total-return aspect to meet our clients' needs. So it's a challenging environment. And from a credit perspective, we look at it and say: "Where are you in the economic cycle?" Beyond that, it's: "What does that cycle look like?

What is the breadth and depth of that?" And when you think about the risk profile in the markets, it's fairly balanced right now. You've had a good backdrop of economic growth. You have supportive policy globally. That's leading to concerns around inflation and what that means for fixed-income or rate markets. At the same time, you've had a maturity of the business cycle, and people are worried about growth slowing down and what that means for the equity portfolio. Credit actually fits nicely into that.

And so we've been pretty positive on how credit fits into a portfolio to provide some income and reduce some of the volatility that you would see in the equity markets, whether it's vol or draw-down risks that you could see.

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